Missed opportunities
Black box thinking sounds all very well in theory, but could it have helped the pension schemes of such high profile business failures such as Tata, BHS and Carillion?
JLT Employee Benefits head of trustee consulting proposition James Auty says: “Throughout the history of each of these schemes, there will have been points at which sponsors could have paid higher deficit payments or when trustees could have better protected the scheme against falling equity markets or lower interest rates.
“I view these moments as missed opportunities rather than past mistakes; with a better understanding of the risks facing their scheme, trustees could have made better decisions,” he adds. “That said, even decisions informed by good understanding are based on predictions about markets and the long-term outlook for the employer covenant, which can often turn out to be wrong.”
Auty continues to explain that by the time trustees realise they have missed an opportunity it is often difficult to be reactive and to rectify this quickly. “For instance, attempts to significantly increase sponsor contributions could come at a time when these are no longer affordable; the decision to de-risk assets against equity market falls or lower interest rates could result in the scheme locking into a deficit which the sponsor will never be able to fund.”
He adds that in the case of Carillion, however, warning signs of covenant weakness will likely have been present for two to three years prior to its collapse, which raises the question of why was action not taken earlier to improve the funding and security of benefits of members?
The lesson here is that trustees need to focus on the basics by monitoring the funding, investment and covenant risks within their schemes to capture opportunities to take remedial action before it is too late.
What went wrong?
Cardano director Stefan Lundbergh explains that black box thinking is about objectively looking at mistakes without pointing the finger of blame. “It is viewing mistakes as learning opportunities that will help us to improve.
“If the trustees of these schemes had applied this type of thinking in the years before the storms gathered on the horizon, I believe they would have been in a better financial position when their sponsors eventually failed,” he adds.
An analysis of past corporate failures would likely indicate that many companies who failed were, at one time, profitable, cash generative and healthy. Indeed, there is no such thing as an employer with a “strong” covenant – only weak covenants and those that have yet to become weak.
With this in mind, Bob Scott, chairman of the Association of Consulting Actuaries, says the lesson for sponsoring employers is that the time to be funding their pension schemes securely is when they are cash generative, profitable and healthy.
“So, when companies are able to pay large dividends to shareholders, they should be paying commensurate amounts to their pension schemes and reducing the investment risk that they take so that, when things turn down, they don’t find themselves with large and unaffordable pension deficits,” he adds.
“In practice employers with “strong” covenants are allowed to defer funding their pension schemes and to take significant investment risk – which didn’t pay off in the cases of BHS and Carillion.”
Hugh Nolan, a professional trustee at Dalriada Trustees and president of the Society of Pension Professionals, takes a different stance. “Each of these cases had specific challenges and it would have been very hard to predict the outcome early enough to do much about it.
“BHS actually had a surplus before the credit crunch and the employer was in no position to remedy the problem after that, given the decline of the company’s fortune in the age of internet shopping,” he adds.
“Tata had reluctantly agreed to continue the British Steel Pension Scheme a year before it collapsed, despite international price pressure on steel. The Carillion trustees or The Pensions Regulator might have somehow managed to squeeze more cash out of the company but they tried for years without success and it is possible that the company would have gone bust sooner if they had managed it anyway.
“Trustees and the regulator have to balance funding requirements against the sustainable position of the employer and we only see the cases where things then go wrong, rather than the many other cases where finding this balance enables the sponsoring employer to stay afloat.”
